AMD: Three Cheers for the New Business Model

By Tiernan Ray

As I mentioned this morning, Advanced Micro Devices (AMD) is surging today on a couple of upgrades, mainly pertaining to the company’s upside potential from the inclusion of its chips in the forthcoming video game consoles of Sony (SNE) and Microsoft (MSFT).

AMD stock today rose 48 cents, almost 12%, to close at $4.45, having steadily added to gains throughout the day.

Today’s rise, mind you, comes after more dour personal computer data on Q2 shipments was released last night by Gartner and IDC.

My colleague Dimitra DeFotisoffers a writeup of the Barron’s bullish point of view on the stock in the Barron’s Take.

Canaccord Genuity‘s Bobby Burleson raised his rating on the stock to Buy from Hold, with a $5 price target, writing that AMD now becomes one of the non-PC-centric names that should outperform PC names given its ramping up of its embedded business, including the console chips.

The company’s revenue is becoming more diverse, he notes: “Management has publically stated they expect 20% of revenue from semi-custom embedded by Q4, and 40%-50% of total revenue within 2-3 years, including SeaMicro ARM-based servers.”

Burleson expects there to be 8 million units of the game machines sold in this second half of the year, and thinks the Street is too conservative on that score: “A minority of sell-side anlaysts currently explicitly include consoles in their 2013 estimates, and where they are included we believe consensus expectations are for roughly 3 million units each for XBOX One and PS4 for a total of 6 million new console units in H2/13.”

The Microsoft and Sony machines are important because they’re part of the titans’ strategy of dominating the living room, and he thinks AMD could score further wins:

We believe MSFT and Sony view game consoles as all-in-one residential media centers through which to offer services, rather than simply gaming devices (MSFT a little more so based on XBOX One’s greater number of connectors versus PS4). In this context, MSFT’s XBOX One would be pitted against Apple (AAPL) TV while other OEMs such as Samsung would likely be looking to get into the mix, offering potential additional socket wins for AMD. Further, AMD stands to benefit on the server front given MSFT is planning 300K servers for XBOX Live, up from 15K last generation. These could be AMD server wins since the servers need to be optimized for graphics and video analysis.

Burleson raised his Q3 estimate for AMD to $1.29 billion and a 1-cent net profit per share from a prior $1.205 billion and a 2-cent net loss, above the Street consensus for $1.22 billion and a 2-cent loss. For the full year, hew models $4.83 billion and an 18-cent loss per share, up from $4.69 billion and a 24-cent loss, and above consensus for $4.77 billion and negative 22 cents.

Merrill Lynch‘s Vivek Arya raised his rating from Underperform to Buy, with a $6 target, writing that the console wins can “transform AMD into a profitable, diversified company with a multi-year recurring revenue stream, away from its inconsistent past under Intel’s shadow”:

“We estimate these APUs will be priced between $60-$100, and we use a $70-$80 range for modeling purposes” referring to the “application processing unit” chips AMD will sell into the PlayStation 4 and Xbox One, writes Arya.

He does a back-of-the-envelope on the console chips’ potential profit, positing slightly fewer units than does Burleson:

Our published AMD model assumes 5.7mn console APUs at $81 a piece in 2013 with units growing to 15.4mn in 2014 but ASPs declining to $75. We also assume a 15% operating margin contribution from console processor sales given our expectations of ~30% gross margins for such chips, ~15% spending on R&D to make upgrades process node shrinks, graphics, processor architectures upgraded and virtually zero spending on SG&A. This results in a baseline EPS contribution from consoles of $0.09 cents in 2013, and $0.22 in 2014. AMD’s core businesses are still expected to lose $(0.26) in 2013 and $(0.09) in 2014.

Units could be as high as 20 million by 2014, based on some estimates, he notes.

Arya raises his estimts for this year to $4.98 billion in revenue and a 17-cent loss from a prior $4.85 billion and a 25-cent loss.

Also today, Hans Mosesmann of Raymond James, who has long been bullish on AMD shares, reiterated an Outperform rating and a $5 price target, arguing that with a refresh of its PC chips last quarter, he thinks the company “could deliver above market unit trends and/or ASP expansion,” even though he is not expecting any upside to the company’s own 2% quarter-over-quarter revenue growth projection.

Starting this quarter, AMD could surprise in the PC market despite the rollout of new Haswell chips from Intel (INTC), he thinks. The console business is definitely something that could produce upside:

AMD’s sweep of the console business this cycle with two key silicon wins (with both the GPU and CPU), could begin driving upside as early as 3Q13. While the Sony PlayStation 4 and Microsoft Xbox One aren’t scheduled to hit the market until the 4Q13, we believe the ramp could begin in 3Q for AMD and that 3Q13 consensus revenue assuming just 9% growth q/q (seasonal) reflects little to no contribution from consoles. Could PCs Be a Driver? Possibly, with 3Q typically the strongest quarter for AMD. Notably, Gartner’s commentary that Haswell could be a catalyst in 4Q13 leaves potential for AMD to make a splash given that it’s slightly ahead of Intel in addressing the market in 2013.

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